Articles published in the Japan Times

Textbook economists leave casualties in their wakeThe United States and Europe have their trade problems with China, but pause for a moment to consider what is happening in the developing world.

On a recent visit to Lima, Peru, I bought myself a "made in Peru" shirt. The cotton material was excellent, as was the design and coloring -- all areas where Peru can excel. For someone who sees the textile industry as the first step to industrialization in a backward economy -- and anyone who sees the poverty and poverty-driven crime in Peru knows painfully how much that industrialization is needed -- that shirt was a beacon of hope.

But then they told me the shirt firm was about to close. It could not compete with the Chinese products pouring into Latin America under the free trade policies demanded by the World Trade Organization and its textbook economists. The shirtmaker's employees will soon join the ranks of Peru's many unemployed. Peru's excellent cotton fiber will now be sent to China for manufacture into shirts to be sent back to Peru.

It gets worse. To date the economic textbooks have told us that economic progress is simply a matter accumulating and combining the various factors of production -- capital, technology, infrastructure (roads, bridges etc.), entrepreneurship, education and so on. So if Peru wants to catch up with China, all it has to do is go out and acquire the same factors. But in Peru the supply of graduates from the middle and upper classes could well exceed that of many European nations. Peruvian road builders already throw highways over peaks that make Europe's Alps look like peanuts. On every street corner there is a budding entrepreneur trying to sell you knickknacks.

Textbook economists fail to realize the dynamic, boom or bust nature of economic progress. If they had ever tried to run a factory themselves, they would soon discover that the key problem lies in what I call "soft" infrastructure -- trained workers, reliable parts suppliers, repair shops, good communications, capable bureaucrats, experienced bankers and managers -- all the day-to-day items needed to keep a factory in business.

Most of these items can only come from the process of economic development itself. When someone builds a factory, some begin to emerge or improve. This in turn makes it easier to build more factories, which improves the soft infrastructure even more, which in turn allows even more factories to be built. It is a virtuous cycle, and once it gets under way, progress can be like wildfire, particularly if cheap labor and an undervalued currency give you advantages in export markets.

When I first visited China back in the early '70s, its industrial sector was even sadder than Peru's. But smart economic policies have turned bust into boom.

Initially, and like China to some extent, you may have to rely on foreign investors to build the factories needed to get things started. But once started there is no stopping. The 10 percent annual growth rates we see now in China or the 7-8 percent rates we used to see in Japan, then Taiwan and South Korea, and now in India, should be no surprise. They can only be chopped off by rising labor costs. In China and India that day is far away.

But if you are a backward economy and lack even the initial push from say textile factories to get the industrialization process started, a vicious cycle takes over. Without some industrialization, you cannot improve your soft infrastructure. Without that infrastructure, you cannot industrialize, no matter how cheap your labor is. Meanwhile, cheap and good-quality Chinese consumer goods flood in, making it even harder to create new industries. The bust remains bust.

China has become the 400-kg gorilla stomping rival producers around the world out of existence. Advanced economies can use devaluation as a weapon to fight back. But in a backward economy currency devaluation often simply causes inflation and capital flight. The economy worsens. As the poor turn to crime the chances of takeoff get even less.

The Japanese used to, and the Chinese still do, block imports that hurt the industries they see as crucial to their economic future. Why can't Peru and others do the same to protect the labor-intensive manufacturing industries they need so badly for takeoff? The cost to the Peruvian consumer would be minimal; I would have been more than happy to pay the extra few cents needed to allow that Peruvian shirtmaker to remain in business. The ultimate gain to Peru, the world economy, and to humanity, would be enormous. But first we need to restrain those textbook economists.